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The decision of the Spanish Budget Ministry to raise its budget deficit target from 3.5% to 4.5% of gross domestic product has left uncertainty at the long end of Spain’s sovereign market, with even “professional investors saying they can’t handle this anymore”, according to Societe Generale analysts.

Disjointedcurve

The move by the Budget Ministry comes just a fortnight after the deputy budget minister had affirmed the previous targets and were taken as a sign that the Spanish government was retreating from its austerity drive.

This chart, prepared by SocGen analysts, shows the increasingly disjointed nature of the Spanish bond market. The European Central Bank commitment to buy short-dated yields continues to have a positive effect on the short end of the curve, with instruments maturing as late as October 2019 registering a decline in asset swap spreads since Friday.

But the longer term picture remains much more erratic, with the curve inverted in some places – meaning that investors are demanding more compensation for some bonds than they are for much longer instruments which typically would deliver more income.

Asset swap spreads are considered a good gauge of relative value between fixed income instruments because they indicate the difference between the yield of a bond and the Libor curve.

Such is the demand at the short end that the repo rate for some bonds is well into negative territory, meaning that lenders who accept the bonds as collateral are paying to lend on that basis.

“Each bond has got its own story, its own genetics,” said SocGen rates strategist Ciaran O’Hagan. “How it trades depends on how and where it was placed [with investors]. The big point is the uncertainty – the Russian roulette character of this market – which is driving people out of Spain altogether. Even professional investors are saying they can’t handle this anymore.”

Analysts note that while Mario Draghi’s comments on ECB bond-buying of shorter-dated bonds are having a dramatic impact on that portion of the market, the sentiment could reverse at short notice.

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“The Spanish need to be careful about giving any indication that they might not take the funding,” said one. “If the market gets that impression the rally in yields would reverse very quickly and we’d be back to square one.

“At least now if the tightening at the short end continues and yields get down to around 2% investors in search of yield will go further along the credit curve, hopefully bringing down the cost of funding at the longer end as they do so. That dynamic is at risk.”